NISM Series XXI-B Short Notes – Part 2: Investing in Stocks & Fixed Income Securities

 

NISM Series XXI-B Short Notes – Part 2: Investing in Stocks & Fixed Income Securities

This is Part 2 of our 10-part NISM XXI-B (Portfolio Managers Certification) short notes series on PassNISM.in. In this part, we cover Chapters 3 and 4 — Equity Investments and Fixed Income Securities — two of the most concept-heavy chapters in the NISM XXI-B syllabus.

👉 Also Read: Part 1: Investment Landscape & Securities Markets | Free Mock Test

Chapter 3: Investing in Stocks Equity as an Investment

When a company issues equity, it has no contractual obligation to repay shareholders or make periodic payments. Equity investors (shareholders) have a residual claim on net assets — meaning they get paid after all liabilities are settled. Key features of equity investment:

• Voting rights on company affairs
• Opportunity to participate in management when ownership is significant
• Returns not guaranteed; depend on business performance
• Long-term wealth creation potential through capital appreciation

Diversification of Risk Through Equity

The most effective way to reduce portfolio risk is diversification — both cross-sectional (across sectors/stocks at one point in time) and time-series (across different time periods). Diversification works because different business sectors tend to behave differently under economic conditions — they are less than perfectly correlated.

Risks of Equity Investments

• Market Risk: Fluctuations in share prices due to broader market dynamics.
• Sector Specific Risk: Factors impacting a particular industry or sector as a whole.
• Company Specific Risk: Factors specific to a single company (management, product failure, etc.).
• Liquidity Risk: Measured by impact cost — the percentage price movement caused by a specific order size. Higher impact cost = lower liquidity.

Preference Shares vs Equity Shares

Preference shares rank above equity in terms of dividend payment and distribution of assets during liquidation. However, preference shares usually don't carry voting rights. Types include: participating, non-participating, and convertible preference shares.

Equity Research and Stock Selection

Equity research involves analyzing a company's financial and non-financial information, sector dynamics, competitors, and macro-economic environment.

Fundamental Analysis

The process of determining the intrinsic value of a stock based on economic factors like future earnings, cash flows, interest rates, and risk variables. Two approaches:

• Bottom-Up Approach: Starts from company-specific factors and moves up to macro factors.
• Top-Down Approach: Starts with macro-economic analysis → selects industries → zeroes in on companies.

Sell-Side vs Buy-Side Analysts

• Sell-Side Analysts: Work for brokerage/investment banking firms; publish research reports with buy/hold/sell recommendations for external clients.
• Buy-Side Analysts: Work for mutual funds, hedge funds, pension funds, PMS; generate investment recommendations for internal use.

Stock Analysis Process (Three Steps)

1. Economic Analysis – Understand the macro-economic environment (GDP, inflation, interest rates, policy changes).
2. Industry/Sector Analysis – Use Porter's Five Forces to assess industry competitiveness.
3. Company Analysis – Study financials, management quality, competitive position.

Porter's Five Competitive Forces

1. Rivalry among existing competitors
2. Threat of new entrants
3. Threat of substitute products
4. Bargaining power of buyers
5. Bargaining power of suppliers

Industry Life Cycle Stages

Introduction → Growth → Maturity → Deceleration/Decline

Stock Valuation Methods 1. Discounted Cash Flow (DCF) Model

The most conceptually sound valuation approach. It requires knowing:

• Stream of future cash flows
• Timing of those cash flows
• Expected rate of return (discount rate)

Two types of cash flows used in DCF:

• FCFF (Free Cash Flow to Firm): Cash flows before any debt payments.
• FCFE (Free Cash Flow to Equity): Cash flows available to equity investors after deducting interest and adding net borrowings to FCFF.

2. CAPM – Cost of Equity

Ke = Rf + β × (Rm – Rf)

Where: Ke = Cost of Equity, Rf = Risk-Free Rate, β = Beta, Rm = Market Return

3. Asset-Based Valuation

Used for asset-heavy businesses (real estate, shipping, aviation). Value = Total Assets – Total Liabilities.

4. Relative Valuation

Value a company by comparing it with peers using valuation multiples.

Important Valuation Ratios

Ratio	What it Measures
PE Ratio (Price/Earnings)	How much investors pay per rupee of earnings
PB Ratio (Price/Book Value)	Market price vs. book value of equity
PS Ratio (Price/Sales)	Valuation relative to revenue
PEG Ratio (PE/Growth)	PE adjusted for earnings growth rate
EV/EBITDA	Enterprise value relative to operating earnings
EV/Sales	Enterprise value relative to revenue
EVA / MVA	Economic and Market Value Added — measure of value creation

Technical Analysis

Technical analysis is based on the premise that all available information — fundamentals, economic data, market sentiment — is already reflected in the stock price. It uses past price and volume data to forecast future price movements.

Three Essential Elements in Technical Analysis

1. History of past prices — reveals underlying trends and direction
2. Volume — indicates the strength of a price trend
3. Time span — accounts for long-term influences on prices

Key Assumptions

• Market prices are determined by supply and demand.
• Supply and demand are governed by both rational and irrational factors.
• Prices move in trends; trends persist for significant durations.
• Trend changes can be detected from market price-volume action itself.

Popular Technical Indicators

• Trend Line Analysis
• Moving Average Analysis
• Bollinger Band Analysis

Chapter 4: Investing in Fixed Income Securities Overview of the Fixed Income Market in India

India's fixed income market is classified by the type of issuer: Central Government, State Governments, public bodies, banks, statutory corporations, and other corporate bodies.

What is a Bond?

A bond (fixed income security) is a contract where the issuer promises to:

• Pay a fixed periodic interest amount (called coupon)
• Repay the original amount (called face value / principal) at the end of the maturity period

The three most important intrinsic features of a bond: Coupon Rate, Maturity Period, and Principal/Face Value.

Bonds with Embedded Options

• Callable Bond: Issuer has the right to redeem the bond before maturity.
• Putable Bond: Investor has the right to sell the bond back to the issuer before maturity.
• Convertible Bond: Can be converted into equity shares of the issuer.

Bond Safety and the Indenture

The indenture is the legal agreement between the bond issuer and bondholders. It specifies par value, coupon rate, maturity, collateral, seniority of payments, and other terms. Credit rating agencies assess the probability of default and assign credit ratings after analyzing the issuer's financial ability.

Bond Pricing

The price of a bond equals the present value of all its future cash flows (coupons + face value), discounted at the Yield to Maturity (YTM).

Bond Yield Measures

Yield Measure	Formula / Definition
Coupon Yield	Annual coupon ÷ Face Value × 100
Current Yield	Annual coupon ÷ Current Market Price × 100
YTM (Yield to Maturity)	Discount rate that equates the PV of future cash flows to the current market price. It is the expected return if the bond is held to maturity.

Bond Pricing Conventions (Must Know for Exam)

• Bond at Discount (Price < Face Value) → YTM > Coupon Yield
• Bond at Premium (Price > Face Value) → YTM < Coupon Yield
• Bond at Par (Price = Face Value) → YTM = Coupon Yield

Price Volatility of Bonds (4 Key Relationships)

1. Bond prices and interest rates have an inverse relationship (rates up = prices down).
2. Higher coupon bonds show smaller percentage price changes for the same rate movement.
3. Longer maturity bonds experience larger price changes for the same yield change.
4. A decrease in yield raises bond prices more than an equal increase in yield lowers prices (this is convexity).

Interest Rate Risk and Reinvestment Rate Risk

• Interest Rate Risk: Risk that changes in market interest rates will affect the market value of the bond portfolio.
• Reinvestment Rate Risk: Risk that future coupon payments will be reinvested at a lower rate.

Duration (Macaulay Duration)

Duration is a measure of the time taken to recover the initial bond investment in present value terms. In simple terms, it is the payback period of a bond — the time needed for the bond to repay its own purchase price. Duration is expressed in years.

• Longer maturity = Higher duration = Greater price sensitivity to interest rate changes
• Higher coupon = Lower duration

Quick Revision Box – Part 2

• Equity = residual ownership; no contractual return; voting rights
• DCF is the most theoretically correct valuation method
• CAPM: Ke = Rf + β × (Rm – Rf)
• Bond price and yield move in opposite directions — always
• YTM > coupon yield = bond trading at discount
• Duration = time to recover bond investment (in PV terms)
• Higher coupon → lower duration; longer maturity → higher duration

👉 Continue Reading: Part 3: Derivatives, Mutual Funds & Role of Portfolio Managers

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👉 Check Syllabus: NISM XXI-B Exam Syllabus